Sundaram v. Freshworks Inc

Background

This securities class action concerns Freshworks’s September 2021 initial public offering. Lead Plaintiff Mohan R. Sundaram alleged that Freshworks’s prospectus and registration statements presented strong growth while failing to disclose that three financial metrics had slowed during the third quarter of 2021: year-over-year revenue growth, calculated billings growth, and net dollar retention.

Freshworks’s third-quarter results were announced after the offering. Revenue growth fell from 56% in the second quarter to 46% in the third quarter; calculated billings growth fell from 61% to 41%; and net dollar retention fell from 118% to 117%. Freshworks’s stock fell 14% the day after the announcement. The defendants moved to dismiss the consolidated amended complaint under Federal Rule of Civil Procedure 12(b)(6), which tests whether the complaint states a legally sufficient claim.

Section 11 Claims

Section 11 of the Securities Act of 1933 imposes liability for material misstatements or omissions in a registration statement. The court rejected Sundaram’s claim based on the historical financial figures disclosed in the offering documents. Sundaram did not allege that those figures were inaccurate, and the court held that the offering documents’ historical data did not create a materially misleading impression.

The court also held that Freshworks generally had no duty to disclose financial results from a quarter still in progress. It concluded that the third-quarter figures were not an “extreme departure” from Freshworks’s historical results because the figures remained within the range of earlier results.

The court rejected the argument that Freshworks’s general statements about rapid growth, a healthy net dollar retention rate, and a healthy revenue mix were actionable. It characterized those statements as corporate optimism that did not materially misrepresent Freshworks’s financial condition.

Regulation S-K Item 303

Item 303 of Securities and Exchange Commission Regulation S-K requires disclosure of known trends or uncertainties reasonably likely to have a material effect on revenue, income, or financial condition. The court held that Sundaram plausibly alleged an Item 303 violation. At the motion-to-dismiss stage, the court found it plausible that the third-quarter slowing growth rates reflected a persistent business trend, that the defendants knew about the adverse trend, and that the trend was reasonably likely to have a material effect on Freshworks’s financial condition.

The court therefore denied the defendants’ motion to dismiss the Item 303 claim.

Regulation S-K Item 105

Item 105 requires an offering document to discuss significant factors that make an investment speculative or risky. The court held that Freshworks’s risk disclosures were adequate and were not misleading. The disclosures warned that revenue growth could decline, quarterly results could fluctuate, and renewal rates and customer churn could affect the company’s business and financial condition.

The court granted the motion to dismiss the Item 105 claim, but granted leave to amend. It concluded that amendment would not necessarily be futile because Sundaram could add facts concerning whether the third-quarter deceleration was exceptional and outside Freshworks’s historical range.

Section 12(a) and Section 15 Claims

Sundaram had also asserted a claim under Section 12(a) of the Securities Act. He conceded that claim in briefing, and the court granted the defendants’ motion to dismiss it with prejudice.

Section 15 imposes secondary liability on control persons for an underlying Section 11 violation. Because the court found that Sundaram plausibly alleged an Item 303 violation, it also found that he plausibly alleged the required underlying Securities Act violation for Section 15. The court further found that the individual defendants were plausibly alleged to be control persons based on their positions at Freshworks. It therefore denied dismissal of the Section 15 claim.

Disposition

The court denied the defendants’ motion to dismiss the Item 303 and Section 15 claims. It granted with prejudice the motion to dismiss the Section 12(a) claim. It granted with leave to amend the motion to dismiss the Item 105 claim and the Section 11 claims based on failure to disclose the third-quarter decelerating growth rates and on statements allegedly creating a materially different impression of Freshworks’s financial condition. The order thus granted in part and denied in part the defendants’ motion to dismiss.